Monday, January 9, 2012

Fama/French Forum: "Q&A: Seeking the Inefficient Asset Class"

There are little treasures scattered everywhere on the internet, here's one of them.
From the Fama/French Forum at Dimensional Fund Advisors....

Which is as good an intro as any for:

We often hear the claim that some markets
are less efficient than others—small company stocks, emerging markets,
foreign exchange, and so on. Is there any evidence to support this
assertion?

EFF: Nothing convincing we know of.

KRF: It is interesting to consider a few of
the arguments behind this conclusion. One of the simplest is that there
are neglected assets. If no one is paying attention to a group of small
stocks, for example, how could their prices possibly be accurate?
Although I am skeptical, this argument may have had some merit 150 years
ago. It seems implausible today, however, given modern technology and
the hundreds of billions of dollars investors spend each year trying to
find pricing errors.

A closely related argument is that investors in some markets are ripe
for the picking because they are just not as sharp as the rest of us.
This seems to be the logic behind some investors' belief that emerging
markets are less efficient than developed markets. It does not take much
thought to reject the premise of the argument. People are bright and
highly motivated in markets around the world. But even if we ignore that
fact, there are so many developed-market investors looking for
opportunities in emerging markets (and so many emerging-market investors
looking for opportunities in developed markets), it again seems
implausible that differences in ability produce differences in the level
of efficiency.

Perhaps the most sophisticated justification for these claims is based
on Shleifer and Vishny's (1997) limits of arbitrage argument. This
theory suggests that if there are pricing errors, they will be larger in
markets with relatively high trading costs and other frictions. For
example, in many regions of the US, residential real estate commissions
are 6%. These costs prevent informed real estate investors from setting
up trading strategies to exploit relatively large deviations from the
"right" price. In other words, pricing errors may persist because active
strategies designed to exploit them are hampered by trading costs and
other frictions...MORE